Ma Bell's Future On the Line - Company Operations

After trying cable, wireless and local phone service, AT&T's Michael Armstrong still searches for a winning strategy.

IT'S TAKEN ONLY 20 YEARS, FOUR CHIEF executives, innumerable spinoffs and divestitures, and lots of government meddling, but AT&T, the former U.S. phone monopoly, has come undone. Investors have grown tired of waiting for the company's ballyhooed cable acquisitions to pay off, while its core phone and business services look more old-economy by the day. Embattled CEO Michael Armstrong may yet pull a rabbit out of his hat, but one thing is certain: The old phone company is dead.

As AT&T directors gathered late last week to set a new course for the company, a number of possible scenarios were being played out in the press. The strategic battles were being waged over possible merger partners that included British Telecom and wireless player Nextel. The personal battle over the company's direction was being fought between Armstrong and the company's biggest individual shareholder, John Malone, chairman of AT&T-owned Liberty Media.

With its stock in the doldrums, this is a pivotal moment in AT&T's history. Armstrong will either emerge validated, or with his leadership in question and the possibility of AT&T crumbling into warring states, waiting to be sold off. Whatever the outcome of this latest round of soul-searching, it's increasingly possible that Ma Bell may never catch up with her more nimble progeny.

On the surface, it's hard to see why the market has so emphatically dismissed AT&T, a company that pulled in $62 billion in revenue in 1999, and whose core business -- long-distance phone service -- is still a money machine, churning out $20 billion last year. Nonetheless, as of late last week, the company's stock was trading at about $30 a share -- about half its value in April. One reason is that its core business is eroding fast. The company expects consumer phone revenue to decline about 8 percent this year.

John Petrillo, AT&T's VP of strategy and business development, says long distance still has a full decade of life. But new wireless and fiber-optic networks could hasten that timetable. Evidence of this is how the market values AT&T's phone business. If AT&T sold off its conventional phone unit, it would fetch a much lower premium than what a $20 billion business in a healthy sector would attract.

But the problems run deeper than that. To reshape AT&T as an Internet company, Armstrong bet big on assembling a cable system over which the company plans to offer phone, Internet, television and other services. Not only has the $112 billion bet saddled the company with a mountain of debt, it's hardly a given that cable will win out over DSL and other broadband technologies.

Recent moves have brought equally mixed results. The spinoff of AT&T Wireless created a $50 billion tracking stock but failed to provide the hoped-for lift the mother ship needs. Just last week, the company's Latin American ISP had to shelve its planned IPO.

In short, the deftness that Armstrong showed in reshaping Hughes Electronics -- which helped persuade Wall Street he was on course during his first two years at AT&T - has been in short supply. Armstrong needs a big score. The question is, does BT or Nextel fill the bill?

The story of how AT&T arrived at this point is a cautionary tale of a former monopolist losing its way in a helter-skelter world of deregulation and rapid technological change. After the 1984 breakup of the Bell companies, AT&T floundered. Astutely realizing that computers had a big future, Ma Bell acquired NCR - in 1991, just when the hardware business showed signs of plateauing. A major investment in wireless - $11.9 billion for McCaw Cellular in 1994 - followed. Then in 1996 began the great "trivestiture," as it was called internally: the voluntary reorganization into Lucent (the former Bell Labs), NCR and AT&T, the phone company. Thus, under Bob Allen, Armstrong's predecessor, it became clear that while the world had changed, AT&T had not advanced far at' all.

One of Armstrong's first moves was to shed thousands of employees - always a quick and dirty way to please Wall Street. But those losses, coupled with the hundreds of salespeople who left AT&T to join the Concert joint venture with BT, left the company with gutted, underperforming service and sales groups. Customers fled, and projections were revised for the business services group; the whole company had to restate its estimates. "We're still suffering" from the shortfall, says Petrillo. "But we've been chastened and we're remorseful about it."

Meanwhile, Armstrong was attempting to follow through on his promise to "transform AT&T from a long-distance company to an 'any-distance' company" that "connects [people] to information in any form that is useful - voice, data and video."

Rolling out new digital cable services - the heart of this "any-distance" company - has proven elusive. Upgrading the cable networks the company bought, particularly those of Tele-Communications Inc., has been a nightmare of cost overruns, delays and poor service. In the Denver area (TCI's home turf), the company has invested $200 million in rehabilitating the cable network.

Even worse, thanks to federal regulations that prohibit any one cable operator from owning more than roughly a quarter of the nation's cable networks, Armstrong needed to make deals with other cable giants, including Time Warner, Cox and Comcast, to offer phone service on their cable systems. In January 1999, AT&T made an auspicious announcement: a deal to deliver voice service over Time Warner's system. But after months of delays, that deal finally collapsed in the face of the pending AOL-Time Warner merger - a blow from which, some AT&T watchers maintain, Armstrong has yet to recover.

AT&T executives still assert the cable strategy will pay off. The company has upgraded 850,000 customers and hopes to add more than 2.2 million this year. But signing up another 400,000 to 500,000 cable phone customers this year, as AT&T has promised, looks like a tough haul.

From within, AT&T is trying to remake itself by moving all phone and data services to the Internet. Though Internet networking now accounts for about a third of business revenue, growing more than 20 percent last quarter, it's a long process. By last June, the company was hosting Web sites for more than 10,000 businesses.

But its Internet service arm, AT&T WorldNet, has faltered, with subscribers stalling at around 2 million. And the uninspiring wireless IPO - the stock is now treading water at $22 a share - means that Armstrong is still seeking a convincing long-term Internet strategy.

AT&T, of course, isn't the only telecommunications company to lose its way. Phone service rivals WorldCom and Sprint thought a megamerger would lead to success. When that deal fell through, their stocks tumbled along with AT&T's: Sprint trades in the mid-$20s after reaching $75 a share in the past year; WorldCom hovers at around $25 a share, down from a 52-week high over $61.

For AT&T, an alliance with British Telecom seems -- like British Petroleum and Amoco -- a natural match. Both are national phone companies with maturing core businesses, and with CEOs looking for a quick path to renewed global pre-eminence. The companies already have an international joint venture for big corporate accounts, Concert, and have been in ongoing talks regarding new ventures. But combining the companies would turn AT&T from a national power with sagging fortunes into an international giant with an uncertain future, since it would face the same competitive pressures, only on a grander scale.

British Telecom, after all, has been criticized for attempting to plow ahead in fixed, mobile and Internet businesses instead of narrowing its focus. Like Armstrong, BT CEO Sir Peter Bonfield has made some questionable calls of late, such as the failed bid for Italian fixed-line operator Infostrada. Bonfield's position is, if anything, more tenuous than Armstrong's. And the regulatory hurdles to yet another big telecom merger would be huge.

A more focused combination -- of AT&T Wireless or some other business unit with BT -- could be more appealing. But British Telecom leadership shows no signs of relinquishing control of the company's high-flying wireless business.

As the AT&T board conferred, the more-likely deal appeared to be a merger between AT&T Wireless and Nextel. Talked about for weeks, the merger was under discussion at the directors' retreat, according to sources familiar with the situation.

Such an alliance would add Nextel's 5 million high-paying business subscribers and help AT&T win back investors impatient for faster growth. But this deal too would face regulatory and technical hurdles, since the companies serve some of the same cities -- but have incompatible technologies. Nextel might actually be a better takeover prospect for an international company looking for an entree to the U.S. market. If a deal does happen with AT&T, it would be the second time wireless investor Craig McCaw has sold his company to AT&T: He pocketed billions in the 1994 cellular buyout.

But even the Nextel merger would likely be seen as a defensive maneuver, and would do little to address the company's deep-seated problems. Right now, despite a series of moves to woo Wall Street, the biggest issue is the stock. No matter how you look at it, AT&T is undervalued. The entire company is now valued at little more than it paid for all of its cable assets.

When Armstrong bought the cable properties, investors began trading the ultimate blue chip like an Internet company, subjecting it to the volatile and often capricious valuations the market gives fast-moving dot-com stocks. AT&T largely avoided the April downturn that affected most stocks, but when the company downgraded its quarterly earnings last May, its stock bottomed out.

And wheeling and dealing won't turn AT&T into an instant Net powerhouse. If Armstrong strikes more deals for the wireless unit, he risks losing control over the fastest-growing part of the company. Like BT, Nextel executives are unlikely, should a merger take place, to cede control over the combined entity to AT&T managers.

The unknown element here, of course, is John Malone. Like Ted Turner within Time Warner, Malone is a maverick who is the company's largest individual stakeholder. Unlike Turner, who's been largely neutralized at Time Warner, Malone has been publicly critical of Armstrong's leadership and the company's direction, making him a potentially dangerous rogue director. It's unclear how much sway he has with other AT&T board members, but if Armstrong's latest proposals fail to convince them -- or if he can't deliver on his promises -- Malone will almost certainly push to break up and sell off chunks of the company. And if AT&T stands still, it has little chance of winning back investors.

It's an intriguing struggle: Armstrong the amiable company-builder vs. Malone the Machiavellian deal-maker. The latter essentially wants to further dismantle the broken-up Ma Bell. And Armstrong, who has no intention of letting AT&T hit the rocks on his watch, will fight to stay the course with his broadband cable strategy, figuring time is on his side.

Post-Breakup Blues

1984

The Bell System monopoly is broken up into eight companies. AT&T, which holds onto the long-distance and phone equipment businesses, is valued at $18 billion.

1991

Buys computer maker NCR for $7.3 billion to get into hardware business.

1994

Moves into wireless by acquiring McCaw Cellular for $11.5 billion.

1995

Announces largest voluntary restructuring of a U.S. company. Lucent, the former Bell Labs, spun off in September 1996; NCR follows in January of 1997.

1996

Launches AT&T WorldNet dialup Internet service.

1997

Armstrong becomes chairman, with mission of turning AT&T into a global voice and data company.

1998

Buys TCG for $11.3 billion, entering local phone service market.

March 1999

Spends $48 billion on TCI in bid to become major provider of cable services.

April 1999

Announces Concert, a joint venture with BT, to create international network of Web hosting centers.

April 2000

AT&T Wireless spins off in largest IPO in history; opens at $30 and closes at $32.

June 2000

Completes deal for cable firm MediaOne for $44 billion. Current market cap: $112 billion.

Being Like Mike

Under attack on Wall Street and in the press, AT&T chief Michael Armstrong finds himself playing a high-stakes game to maintain control of an iconic American company. During his three-year tenure at the helm of the U.S. telephone giant, the 61-year-old executive has shied away from few gambles. A Harley-Davidson rider in his spare time, Armstrong has bet the company's future in a series of wagers that have yet to pay off.

His biggest one yet -- the decision to spend more than $100 billion to buy cable companies Tele-Communications Inc. and MediaOne Group, steering Ma Bell toward the world of broadband communications -- is now his biggest liability. Those moves have locked AT&T into a strategy of providing high-speed data service over cable modems at a time when competing technologies, such as digital subscriber lines, look potentially more promising.

Then again, it was this kind of decisive risk-taking AT&T's board wanted when it picked Armstrong to succeed Bob Allen in October 1997. The AT&T directors knew they needed to overhaul their old-economy long-distance business for the digital age. In his six-year stint as chairman and chief executive of Hughes Electronics, the affable executive with the disarming smile transformed the General Motors spinoff from a defense contractor to a commercial satellite and electronics company while pioneering its DirecTV satellite television service.

Before that, Armstrong spent 31 years at IBM, where he rose from a systems engineer to a senior vice president.

Among his first accomplishments at Ma Bell was reducing the company's bloated management ranks, something Allen had never figured out. Seen as convincing and aggressive, able to wow a boardroom or an industry with his vision, Armstrong quickly settled on a strategy to reshape AT&T.

"As we enter the new millennium, AT&T is successfully transforming itself from a domestic long-distance company to an any-distance, any-service, global company," reaching beyond voice service to data and video, he wrote this March in the company's annual report. "There's no stopping us."

Wall Street rewarded him, sending AT&T's share price to highs of $64 in January 1999. But now Armstrong, in his quest for a new strategy for the telecom giant, has "overpromised," says Rex Mitchell, an analyst at BB&T Capital Markets. "He's had a tough story to tell."

Last week, Armstrong was selling that story to an increasingly skeptical public and board of directors. He clearly knows how to turn around a big company. But his moves at AT&T have been singles, not triples. And the game is stretching into the late innings.

Mark Boslet

The Unbeatable Lightness of John Malone

The onetime king of cable is now the emperor of broadband. Does he really want to reign over AT&T?

As CEO of Tele-Communications Inc., John Malone developed a reputation as the sharpest operator in the cable business. His steel nerves and canny dealmaking squeezed money from partners while leaving him in charge. Now Malone could be making an unprecedented play to control the destiny of AT&T.

The 59-year-old Malone began his career at Ma Bell as an economic planner at Bell Labs. After a brief gig as a consultant with McKinsey & Co., he joined General Instrument and became president of Jerrold Electronics, a GI subsidiary that supplied set-top boxes for the cable industry. In 1973, TCI founder Bob Magness signed Malone as CEO.

Malone built TCI, based in Denver, by gobbling up hundreds of small, rural cable systems. By 1999 he had created a cable TV giant with 14 million subscribers, plus an accumulated debt of $16 billion. AT&T bought TCI that year for $48 billion.

The deal was classic Malone. For a premium price, he off-loaded to AT&T the financial burden of upgrading TCI's cable system for digital services -- a job that has proved more expensive than expected. Malone got an AT&T board seat and a stock grant making him the company's single largest shareholder. He also carved out a new niche as chairman of Liberty Media, a Denver-based AT&T subsidiary with a separate tracking stock.

Liberty, formerly TCI's content arm and now a worldwide cable-investment vehicle, owns significant stakes in numerous content companies -- including the Discovery and USA cable networks, News Corp., Time Warner and TV Guide -- as well as an extensive empire of cable systems in Asia, Europe and Latin America.

In July, as AT&T's stock fell deeper into a hole, Malone gave an extraordinary interview to the Wall Street Journal, criticizing CEO Michael Armstrong's running of the company. He recommended spinoffs that would transform AT&T into a "holding company" -- managed like Liberty as a financial empire with a hands-off, strategic vision.

Having publicly snubbed Armstrong, what's Malone after? Perhaps he dreams of taking the helm at AT&T. More likely, he just wants the person in charge to pay him heed.

Dominic Gates

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